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Topic: Rental Properties? (Read 11240 times)

Iíve only purchased vacant residential land, and my ďstrategyĒ was to buy in areas in Charlotte, near where I live, where some development was happening, I.e. houses being flipped new homes being built, etc.

This area Usually includes some less sophisticated owners (sellers) and people who are happy to get a little pop on a property that had been stagnant for many years.

So, I guess I tend to look for tweeners in terms of quality.

Another little goal of mine has been to buy a property with a lot of land attached. If you can work it so that you get a mortgage on the whole value of the house plus land(acreage), you own a levered investment financed with leverage.

Why is land leveraged? Think about a $100,000 house. The rule of thumb that Iíve read about a few places is that the land under a property is worth typically 20% of the total value. Thatís a rule of thumb, so in cities land will be worth more as a % and in rural areas the land will be worth less. Additionally, the structure is itself a depreciating asset. So, when people say home prices are going up, itís primarily the value of the land going up.

But in short, if home prices increase 2-3% per year, that $100,000 house is up to $102-103,000 and $20,000 is up to $22-23,000, a 10-15% increase.

NYC, SF, and other gateway international cities are all about land prices and the inflation of future construction cost. Typically, the land and the actual structure (foundation, wall, etc) don't depreciate and if anything appreciates over time because the cost of materials and labor to build that go up over time. What do depreciate overtime are your appliances, roof, siding, windows, fixtures, flooring, paint, etc. If you ask me back in 2002, I would've say buy the RE that pays 8% yield. In 2018, I would say that buy the 4% cap rate stuff where you believe in 10 years the land value and the construction cost will be much higher. In order to justify 4% cap rate, you have to have very special markets like land constraints plus job growth. Once you get out of NYC/SF, you need to adjust your cap rate significantly higher.

Iíve only purchased vacant residential land, and my ďstrategyĒ was to buy in areas in Charlotte, near where I live, where some development was happening, I.e. houses being flipped new homes being built, etc.

This area Usually includes some less sophisticated owners (sellers) and people who are happy to get a little pop on a property that had been stagnant for many years.

So, I guess I tend to look for tweeners in terms of quality.

Another little goal of mine has been to buy a property with a lot of land attached. If you can work it so that you get a mortgage on the whole value of the house plus land(acreage), you own a levered investment financed with leverage.

Why is land leveraged? Think about a $100,000 house. The rule of thumb that Iíve read about a few places is that the land under a property is worth typically 20% of the total value. Thatís a rule of thumb, so in cities land will be worth more as a % and in rural areas the land will be worth less. Additionally, the structure is itself a depreciating asset. So, when people say home prices are going up, itís primarily the value of the land going up.

But in short, if home prices increase 2-3% per year, that $100,000 house is up to $102-103,000 and $20,000 is up to $22-23,000, a 10-15% increase.

Hopefully the light rail extension does for the north side what it has done to the south side. Property values are up 25-30% Y/Y in some places in south end/dilworth

Why is land leveraged? Think about a $100,000 house. The rule of thumb that Iíve read about a few places is that the land under a property is worth typically 20% of the total value. Thatís a rule of thumb, so in cities land will be worth more as a % and in rural areas the land will be worth less. Additionally, the structure is itself a depreciating asset. So, when people say home prices are going up, itís primarily the value of the land going up.

But in short, if home prices increase 2-3% per year, that $100,000 house is up to $102-103,000 and $20,000 is up to $22-23,000, a 10-15% increase.

Interesting. However that logic only works if you have the opportunity to redevelop the property to build more units or turn it into a higher value property. Otherwise the calculus changes.

NYC, SF, and other gateway international cities are all about land prices and the inflation of future construction cost. Typically, the land and the actual structure (foundation, wall, etc) don't depreciate and if anything appreciates over time because the cost of materials and labor to build that go up over time. What do depreciate overtime are your appliances, roof, siding, windows, fixtures, flooring, paint, etc. If you ask me back in 2002, I would've say buy the RE that pays 8% yield. In 2018, I would say that buy the 4% cap rate stuff where you believe in 10 years the land value and the construction cost will be much higher. In order to justify 4% cap rate, you have to have very special markets like land constraints plus job growth. Once you get out of NYC/SF, you need to adjust your cap rate significantly higher.

Based on the number of cracked foundations I've seen I would say that that foundations and walls do indeed depreciate.

Residential construction of the past few decades does have a limited life.

I would think that property in CA, and ESPECIALLY San Francisco would have to have a somewhat higher cap rate to reflect the odds of a really big earthquake hitting.

SF was wiped out a bit more than 100 years ago. Are they overdue? Hard to say, but the odds are greater than 0.

I also think that there is more/safer money to be made in other parts of the country (Midwest, South) where cap rates are MUCH higher. I'm looking at some commercial properties that are at about a 9%-10% cap rate. Greater chance those could go to a 8% cap rate than SF goes from 4% to 3%?

OR

What happens if the economy slows down/goes busto? What if cap rates across the country go up 2%? Everybody take a loss! Losses are bigger in a 4% to 6% rate than a 9% to 11% rate.

I would think that property in CA, and ESPECIALLY San Francisco would have to have a somewhat higher cap rate to reflect the odds of a really big earthquake hitting.

SF was wiped out a bit more than 100 years ago. Are they overdue? Hard to say, but the odds are greater than 0.

I also think that there is more/safer money to be made in other parts of the country (Midwest, South) where cap rates are MUCH higher. I'm looking at some commercial properties that are at about a 9%-10% cap rate. Greater chance those could go to a 8% cap rate than SF goes from 4% to 3%?

OR

What happens if the economy slows down/goes busto? What if cap rates across the country go up 2%? Everybody take a loss! Losses are bigger in a 4% to 6% rate than a 9% to 11% rate.

We'll see!

One potential upside to San Francisco is that supply is constrained not only by the water around the city, but by the water between the ears of certain influential citizens. Trying to get permits for new construction isn't necessarily easy there, which reduces competition for existing buildings.

I probably wouldn't buy anything that was subject to their rent control though.

I would think that property in CA, and ESPECIALLY San Francisco would have to have a somewhat higher cap rate to reflect the odds of a really big earthquake hitting.

SF was wiped out a bit more than 100 years ago. Are they overdue? Hard to say, but the odds are greater than 0.

I also think that there is more/safer money to be made in other parts of the country (Midwest, South) where cap rates are MUCH higher. I'm looking at some commercial properties that are at about a 9%-10% cap rate. Greater chance those could go to a 8% cap rate than SF goes from 4% to 3%?

OR

What happens if the economy slows down/goes busto? What if cap rates across the country go up 2%? Everybody take a loss! Losses are bigger in a 4% to 6% rate than a 9% to 11% rate.

We'll see!

One potential upside to San Francisco is that supply is constrained not only by the water around the city, but by the water between the ears of certain influential citizens. Trying to get permits for new construction isn't necessarily easy there, which reduces competition for existing buildings.

I probably wouldn't buy anything that was subject to their rent control though.

The water between the ears of certain influential citizens is exactly correct. Cities like NYC and SF are notorious for there difficulty in bringing new supplies to the market. There really aren't any giant developable land lots. Most new development is knock down of older structure and re-build. It's very expensive to bring on new supplies this way. Now Hudson yard developments are rare.

I would think that property in CA, and ESPECIALLY San Francisco would have to have a somewhat higher cap rate to reflect the odds of a really big earthquake hitting.

SF was wiped out a bit more than 100 years ago. Are they overdue? Hard to say, but the odds are greater than 0.

I also think that there is more/safer money to be made in other parts of the country (Midwest, South) where cap rates are MUCH higher. I'm looking at some commercial properties that are at about a 9%-10% cap rate. Greater chance those could go to a 8% cap rate than SF goes from 4% to 3%?

OR

What happens if the economy slows down/goes busto? What if cap rates across the country go up 2%? Everybody take a loss! Losses are bigger in a 4% to 6% rate than a 9% to 11% rate.

We'll see!

You're probably right that there should be a slightly higher risk premium for earthquake. Again, the buying of 9-10% cap rate vs a 4.5% cap rate in a land constraint market like NYC. In the last 10 years, the rent that one can charge in NYC has gone up about 70-80%. So if you bought something at a 4% cap rate, it still trades for 4% cap, but you have a 70-80% appreciation in asset value. Leverage that with 70-80% LTV of 30 year mortgage and your equity return is about 2-3x. The thing about owning something in NYC is that the rentals almost never go vacant. I know a lot of people who have 99+% occupancy in the last 10 years, including the tough patch of 2008/2009. I have a friend who bought a single family home on Long Island. His cap rate was probably in that 8% range. But he has a single family home. His carrying cost is much higher, i.e. property taxes. His leasing window is 4 weeks when he rent to college students. If he had to rent to normal working adults, then he deals with some unsavory characters like waiters and waitress who will destroy his house through partying etc. The people who can afford his rent are people with higher risk profile to him like someone who wants to run a day care. If he has an empty house, he's on the hook for over $10k in property taxes alone. The buildings in NYC, we put a sign up that says for rent and we get calls the same day. I've seen examples where tenants decide to move out out of the blue. For rent sign goes up, shows apt to new tenants and new tenant move in 2-3 days later. What I'm describing is in the Queens part of NYC where you have a large immigrant renters. I think they are even better rental markets for the white collar renters in Manhattan. So each market is little cosmos of their own.

I know it's very hard for value investors to justify paying 4% cap rate. Heck, it took me 15 years to figure this stuff out and the whole time I was fighting with my family about "we over paid!" and "we can get a higher cap rate in Pennsylvania". There are tax consequences. For example, your 10% cap rate, you're paying more taxable income tax on it. The 2-3 x appreciation in equity is tax free. If you have the right amount in your W-2s, you can even refi that amount. I was at a conference where David Abrams spoke. He said that he invested in some distressed real estate with 20% yield on it. He said that in hind sight, he would've chose to buy the 15% yield but higher quality assets.

For people from the non-coastal, non-land constraint areas of the US, it's a very different game. To draw a business quality analogy, buying in Detroit is likely like buying a net-net with very high yield, buying in Dallas is likely buying an okay business, and buying in NYC and SF is like buying a Visa/FB/Lubrizol. The have different business qualities and require different valuation methodologies. Like I said, it took me 15 years to figure this stuff. I wish someone else had explain it from the "hard to replace" "Pricing power" and "barrier to entry" approach to me back in 2002. I would've been a lot wealthier.

Regarding the cracked foundation, in NYC, the land is so valuable, you just pay to get it fixed. Heck, people dig up former gas stations, dispose of the tank and then put a building on it. In Queens, the value of the land could be $200 a sqft, it cost you all in about $300 a sqft to build (foundation, structure, plus finishing), and you should earn a $100-200 a sqft profit to take on development risk so that the finish product sells for $600-700 a sqft. If anything happens to your foundation, you pay to get it fixed. But we tend to have pretty good soil and no earthquake in NYC. So the foundation don't crack as often as in Houston where you need to bind the clay with lime treatment so that your foundation don't crack over time.

Regarding the 4% going up 2% in cap rate. If rents go up 70-80%, your former 4% is now 6.5-7.0%. Technically, you still made a bit of money at the new 6.0% cap rate. The issue is "do you have staying power?" Is your building positive or negative carry? In a 99% occupancy, 30 year fixed rate mortgage, rental increase, you can have a move from 4% to 6% and still not lose money. I don't think anyone will be happy with that outcome. But you won't lose your shirt like some sap who bought a SFH in Florida pre 2008. Obviously, if rents stop going up or occupancy drops from 99% to 85%, you have serious issues. Writing this out makes these investments sound like I am bat shit crazy. But then I've known this market for 15-20 years now.

My little real estate is a local business rant is getting a bit long. I'm out.

I've dabbled in this from time to time. Never rented out, but have looked and purchased land.

Location is key. In RE the market seems to be reasonably efficient too. That is nicer places near shopping are more than dumps in a crime ridden area. People seem to ball park the same repair costs too.

If you can do things yourself, or cheap that's when you get a deal. Homes aren't complicated, but there is a learning curve. What I've found with homes and cars is it pays BIG time to learn and understand everything. That way when an electrician comes in to do a $1500 upgrade you know if they're doing it right, and know if they're cutting corners. Tangentially this works with mechanics too. If you go in and say "I have a weird sound" you will get ripped off. But if you learn a little and say "I think a tensioner pully is going" they will talk to you on the level and you will know if their logic works or not.

My advice would be look for hidden issues. Everyone sees bad carpet, or an ugly exterior. Look for knob and tube wiring, look for cracked foundations, water damage, or serious structural issues. Those are the expensive repairs that can destroy any hope of value. Everything cosmetic is fixable.